Sterling slumped to its lowest level against the dollar for nearly a quarter of a century today on persistent fears about the health of Britain's banks and worries that the cost of bailing them out could be a millstone round the economy's neck for many years to come.

The pound fell as low as $1.362 during a hectic trading day, pressured also by bad public finance figures and a speech by Bank of England governor Mervyn King on Tuesday night that indicated that further action would be needed to prevent the economy melting down.

Sterling showed some recovery in later trading in New York on reports that the currency's weakness will be on the agenda at the next meeting of the G7, but it was still changing hands at below the $1.40 level.

The pound's new level marks a 35% tumble since the peak of $2.11 it hit in the summer and is the lowest since the dollar was dropping in late 1985 after the legendary Plaza accords that year when the world's leading economic powers intervened to push the greenback down.

At the beginning of 1985 the pound had almost touched parity with the dollar. That was again being touted as a possibility today.

The possibility of unconventional measures - known as "quantitative easing" - to inject money into the economy also weighed heavily on the currency, after King indicated that such measures could start within weeks. "I fear for sterling," said Standard Bank G10 currency strategist Steve Barrow. "It is the whipping boy of all the major currencies, not just because of the banking-sector problems but also the prospect of quantitative easing.

"Quantitative easing is very negative for a currency, not just because it happens when interest rates are very low but because the point of it is to devalue the currency."

The pound also fell against the euro, to €1.06, although remained above the record lows of about €1.02 hit last week.

The markets ignored a claim from employment minister Tony McNulty that there was "light at the end of the tunnel" for the economy, something the Conservatives said showed he was "out of touch".

The pound's fall may deter Britons from holidaying in the eurozone or the United States but the weak pound should help exporters as their goods and services will be cheaper in the overseas markets.

Data released today highlighted the damage being done to the public finances by the bail-outs of the banking sector and the recession. The figures showed a record public sector net cash requirement of £44.2bn last month, swollen by £20bn of costs related to the recapitalisation of Royal Bank of Scotland.

The government's preferred measure - public sector net borrowing - came in at £14.9bn, just slightly down from November's record high.

Public sector net debt rose to almost £700bn at the end of the year, equivalent to 47.5% of national income. Though that is still low compared with many other countries, it has risen from 30% in 2001 as the government has repeatedly overspent its tax revenues and now that recession and the bank bail-outs have taken their toll. The ONS showed that rescuing banks has added £100bn to the national debt even before the full impact of Royal Bank of Scotland or Bradford & Bingley are counted.

The Bank of England said the monetary policy committee voted 8-1 for a half-point cut to interest rates to a record low of 1.5% this month, with David Blanchflower calling for a full-point cut.

Minutes from the MPC's meeting this month revealed that the policymakers considered keeping rates on hold at 2% to give them time to assess the outlook during their February forecasting round. However, they eventually decided against this as they did not want to surprise the market or undermine confidence.

"Despite the impairment in the monetary transmission mechanism associated with dysfunctional credit markets, a cut of 50 basis points could still have a significant effect on the income of many businesses and households," the MPC argued.

They said the fall in the pound would help support growth and the rebalancing of the economy. But they added that if there were indications that a weakening exchange rate reflected a loss of credibility in UK policy, then that would be bad news for the medium-term outlook.

Jonathan Loynes at Capital Economics said that the minutes "do nothing to undermine the view that further significant monetary policy action is ahead, in the form of lower interest rates and quantitative easing. With the news on the economy still deteriorating dramatically and price pressures fading fast, it seems very unlikely that the MPC's job is done."